The hidden gems – profitable Japanese component makers

The Economist recently ran an excellent article (“Japan’s technology champions – Invisible but indispensable”) about successful medium size Japanese companies that are global market leaders in proprietary high-tech components. As their unique capabilities are so hard to replicate they can enjoy stable and very high profits year after year.

The article mentions several examples of companies that in Japan are labeled chuken kigyo (strong, medium-sized firm). For example, the unknown company Nidec makes 75% of the micro-motors for hard-disk drives in computers. Japan Steel Works is the only company that can make the huge solid-steel vessel that contains the radioactivity in a nuclear power plant. Only the Japanese company has the technology to forge a single 600-tonne steel ingot into the critical $150m part. The Japanese company Murata has 40% of the global market for capacitors and their overall margins (including other lines of business) is around 50%. Shimano earns around $1.5 billion a year by supplying 60-70% of the world’s bicycle gears and brakes. Covalent controls 70% of the market for carbon brushes in electric motors. A few Japanese firms are indispensable in four critical steps in the process of making computer chips: wafer processing; thin-film formation; coating, lithography and developing; and contact and packaging. The success of these companies is a case study for management theory and they hold valuable lessons for the rest of us.

What these companies illustrate is that making a critical component (or module) that that are built on proprietary knowledge can be a very profitable market position if you are the global market leader.

The Japanese chuken kigyo companies take the idea of protecting their unique capabilities to the extreme. They often own their critical supply chains and some firms even make their own production machinery in order to maintain a deep proprietary understanding of their technology. The knowledge about the technology is tacit, not formal. It accumulates by working with colleagues over many years. This poses a barrier to entry for rivals. It is also why these firms try to maintain lifetime employment.

Another contributing factor to their success can be found in Japanese culture. A strong emphasis on quality, structure, and excellence permeates Japanese society. There is right way of doing even trivial tasks such wrapping presents or making tea, and a way of learning to be a master by total concentration and paying attention to details. A work force brought up with this set of values is of course an asset for companies that strive for excellence in complicated technologies.

The German Mittelstands are another example of successful medium size firms that exploit unique proprietary capabilities in a similar way. Features in German culture such as the emphasis on quality, durability, order, structure, craftsmanship and attention to detail have been used to explain the success of the Mittelstands and are strikingly similar to the Japanese value system.

The implication is not that a strategy of excellence in proprietary knowledge only works in Japan and Germany. There are numerous examples of companies that have succeeded in proprietary advanced technology components throughout the world.

Unfortunately, in some countries it would be an uphill battle to go against the dominating work ethics and business culture. The necessary long-term perspective will be hard to accomplish if short-term financial results are allowed to dominate strategic decision making. Preventing high staff turnover will be a problem if the cultural norm is to frequently change jobs. If the norm is to fire staff as soon as there is a dip in revenues, companies will not be able to build staff loyalty. If a country has a substandard work ethic with a laid back attitude about quality, professionalism and service it will be difficult to motivate staff to commit to changing the way they work in order to attain this kind of perfectionism.

A company that wants to emulate this strategy of excellence in proprietary technology should take a hard look at their available competence and capabilities before attempting to implement it. For example, this might work in Sweden but I would be concerned about the lack of attention to detail and the lax work ethic that is prevalent in the Swedish workforce.

However, I do not believe in cultural determinism. Drawbacks can be overcome and firms in other countries can replicate the best parts of the success factors from the Mittelstands and the chuken kigyos.